Mario Draghi kicks the euro down

On Monday, I asked the question: Will Draghi destroy the euro? Yesterday, the EUR/USD dropped another 200 pips following the rather unsurprising news that the European Central Bank (ECB) will not follow the path of the US Fed and embark on full-blown quantitative easing (QE), at least not right away. Instead of using the big bazooka of QE, it has decided to fire its pea shooter in the war against deflation.

It will cut some interest rates to the bone and nudge up the rate it charges banks to park their cash at the central bank. This, they believe, will ‘encourage’ commercial banks to lend more to individuals and businesses in order to stimulate the economy. But if there is one thing the eurozone does not need, it is more debt – the whole place is awash with it.

This is what is meant by pushing on a string – no matter how hard you push, it just doesn’t move the other end.

But with the euro falling like a stone, import prices will tend to increase, raising the prospect of rising consumer prices and put off the dreaded confrontation with deflation – which is one of the main aims of the ECB.

A tramline failure

For swing traders, the collapse in EUR/USD has caused a tramline failure – but the damage was slight. And my tramline method has given me accurate targets.

This was the picture on Monday on the hourly chart:

EUR/USD spread betting chart

The action last Friday where the market was wobbling around my lower tramline caused me to abandon those tramlines as reliable lines of support/resistance. I was then on the lookout for new tramlines.

And with the positive-momentum divergence coupled with the skewed highly bearish sentiment towards the euro, the odds favoured a bounce. But it was not to be – the market collapsed yesterday, thus proving that even with great odds on your side, you can still be wrong!

This game certainly keeps you humble (at least it should).

Incidentally, sentiment indicators are not short-term trade-timing tools. I use them together with my tramline methods to give me high probability entries.

So how does the picture look this morning?

EUR/USD spread betting chart

My search for new tramlines was not in vain. Yesterday, before the big plunge, I drew in T1 and T2 as acceptable tramlines with T2 having a great prior pivot point (PPP). With the upside break of T1, I then drew in T3 as a possible target.

The hunt for a new target

With that tramline break, I had a long trade signal in the 1.3130 area with a protective stop around 1.31 (under the previous low). That gave me a very acceptable risk of 30 pips and was well within my 3% rule margin. That was a proper trade as it followed all of my trading rules.

But the market had other ideas – and duly broke down and stopped me out for a 30-pip loss. That was a textbook example of a head fake, which is really a tramline failure. They do happen, although not too often, thankfully.

Normally I would expect the market to at least pause at T1 in a kiss, but the selling was so intense, the market didn’t even pause when it hit the lower T2.

My question was this: where would the cascade of selling at least pause?

To give me a likely target, I needed to draw in a lower T4 tramline, which now is a target:

EUR/USD spread betting chart

And right on cue, the selling has eased up (or buying has increased!) and the market appears to be staging a base of some sort right on T4.

Once again, being able to draw in multiple tramlines has given me a logical price target.

So let’s review how useful the application of my tramline theory has been here.

• The upward break of T1 gave me a high probability/low-risk long trade.

• That trade failed as the market did not reach T3 and my close stop protected me from a major loss.

• Then, with the market in freefall, I could use T4 as a likely lower target where a bounce of some sort can be anticipated. Aggressive traders will be looking to go long here.

• And if you were short EUR/USD – well done, and you could use T4 as an area to take substantial profits.

So, now this morning, we are left with the intriguing position that the heavily lop-sided bearish euro sentiment has undoubtedly become even more bearish with yesterday’s action.

Earlier in the week, the DSI (Daily Sentiment Index) had declined to less than 10%, which is an extreme last seen in May 2010 – over four years ago. This morning, that figure will surely be even lower.

My question is this: have the euro bulls been completely vanquished? Are there any left? If not, the odds for a major relief rally are even higher now than they were pre-ECB news.

That is one of the many paradoxes of the markets. When an army has been defeated, it is likely to score big gains.